The Guilt of Trading Too Much

By JEFF SOMMER

Published: June 4, 2011

FOR nearly all investors, frequent trading is a terrible proposition. Many people know they trade more than they should — but they just can’t stop.

The fundamental problem with frequent trading is that very few people can consistently outsmart the market — at least not while playing by the rules. Behavioral biases lead many of us to trade at the wrong times. It can be comforting, for example, to buy when stocks are rising and nearly irresistible to sell when they are plummeting, as they did last week. This means buying high and selling low, a fine recipe for financial misery. Furthermore, when costs mount, as they will when you trade frequently, the odds of beating the market are slim indeed.

It’s been long known that these kinds of mistakes have serious consequences. A study by Dalbar, a mutual fund research firm in Boston, found that in the 20 years through December, the average stock fund investor had annualized returns of 3.8 percent, compared with 9.1 percent for the Standard & Poor’s 500-stock index. The average person, in short, would have been much better off buying an index fund and holding it for 20 years.

Now, a new study of affluent investors shows that many well-heeled and apparently well-informed people feel compelled to trade frequently — believing all the while that their trading is excessive. The existence of this “trading paradox” is a central finding of the study, which was conducted by Barclays Wealth, a division of Barclays, the global bank based in London. The study, “Risk and Rules: The Role of Control in Financial Decision Making,” is to be published on Monday. The company provided a copy to The New York Times.

“This trading paradox exists, to one degree or another, everywhere in the world,” Greg B. Davies, the head of behavioral and quantitative finance at Barclays Wealth, said in a telephone interview. “Not everyone is prone to frequent trading, but among those who feel that they must trade frequently to do well, there is a substantial proportion who are troubled by their behavior. This is a novel finding for me.”

At the core of the study was a survey of more than 2,000 affluent people around the world conducted in January and February by Ledbury Research, a market research firm based in London. Participants whose net worth met a minimum threshold (for example, in Great Britain, it was £1 million, and in the United States, it was $1.5 million).

The survey asked participants a series of questions about their behavior. It found that 40 percent said they practice market timing rather than stick to a buy and hold strategy. The market timers were “over three times more likely to believe they trade too much,” the study said. Nearly half of those who said that “you have to buy and sell often” to do well also said “I buy and sell investments more than I should.”

How is it that so many people hold apparently contradictory views, believing both that frequent trading is beneficial and that they trade too much for their own good? The answer isn’t simple, the study said.

“On the face of it,” it said, “you might think that those who were trading more actively would be more experienced, sophisticated and able to control themselves, but that seems not to be the case — trading becomes addictive.”

In fact, the study found, “the basic problem is that investors feel they need to engage in active trading, but they cannot then control how much they do it.”

Much like overeating, over the top trading isn’t easily curbed, Mr. Davies said. It’s like dieting. It’s easy to do — over and over and over again.

Over all, nearly half of the investors said they needed more self-control. Strategies like “setting deadlines to avoid procrastination and using cooling-off periods to reflect on decisions” were widely used, the study found.

Men were more likely to say they engage in market timing than women — 41 percent of men, versus 36 percent of women. That’s in line with research suggesting that women are generally more careful and consistent investors than men. Women were far less likely to say they overtrade — with only 11 percent of women saying they do, versus 17 percent of men.

Based on data collected for the survey, anyway, the United States looks like a fairly sensible place. American investors were generally less prone to the trading paradox than those around the world. Only about a quarter of Americans said they engaged in market timing compared with about half globally. Relatively few Americans — 18 percent compared with 32 percent globally — said they needed to trade often to prosper. Only 8 percent said they traded too frequently, compared with 16 percent globally.

The reasons for this aren’t entirely clear. Mr. Davies said it may be that affluent people in the United States have had more time to grow accustomed to dealing with wealth than, say, people in an emerging market like Malaysia. Switzerland, historically a bastion of wealth, scored even higher than the United States as a haven of financial composure. Within the American sample, Southerners showed the “highest incidence of the trading paradox,” Mr. Davies said, while residents of the Northeast had the least.

FOR older people, the survey contained some very good news. They were generally mellower — exhibiting greater composure, more financial satisfaction and less conflicted behavior. Only 6 percent of the senior group — those 65 and older — said they bought and sold more than they should, for example, compared with 29 percent in the youngest cohort — those under 45. The older people seemed to have picked up some immunity to the trading paradox.

Mr. Davies called this finding “the zen of age.”

“It seems that people are actually becoming wiser as they age,” he said. “They are happier, they have a greater sense of balance — and for many older people this trading paradox seems to have just gone away.”